Brexit in perspective

The impact of Brexit three months on

Figures for the service sector in July confirmed the view that the UK economy did not take a confidence hit to output following the referendum vote. The service sector was up 0.4% on the month and up a lively 2.9% on July 2015. As services are 80% of GDP we can assume that GDP as a whole was usefully positive. So far since the vote we have seen good retail sales figures, reasonable new housebuilding figures, high levels of car output with rising domestic sales, and more growth in exports. The latest PMI survey for September also showed a good advance in the manufacturing figure to 55.4, but this is a sentiment indicator more than a report on what has happened.

At Charles Stanley we consciously took a different view to the consensus. We thought it wrong to predict a post vote sharp slowdown or recession, and thought the UK share index was a clear buy on June 24th given the magnitude of the mark downs. We have also argued that the average growth forecast for next year is too low, given the stimulatory effects of lower sterling, the further monetary action, the likely deficit relaxation and the continuing growth in 2016. Based on Friday’s figures we can look forward to others revising their short term forecasts for this year upwards. More than three months have now passed, and there is no evidence that the economy is in recession or that the short term growth rate has been badly damaged. Most of the independent forecasters and some of the official forecasters are now revising their numbers upwards.

It is still too soon to be sure about 2017. It seems unlikely that Brexit related fall out will slash growth for next year from the Treasury’s 2.2% forecast in March to under 1% as many now estimate, let alone to below zero as some have ventured. Money and credit growth are accelerating and consumer confidence still seems good. More likely sources of bad news are political events on the continent of Europe or in the USA, any further deterioration in the Euro area commercial banking sector, or additional slowdown in China. Some have argued that the negative confidence effects they forecast from a vote to leave the EU have been delayed. They worry that they could come through as news hardens about the timetable and the reality of departure. So far this has not proved to be the case. Following the vote the markets have heard from the new Prime Minister that there will be no re-run of the referendum and no second vote on any agreement with the EU on exit. She confirmed that the UK will not be seeking membership of the European Economic Area, and will not be trying to negotiate a relationship like Norway or Switzerland. These ideas have been called by some “soft Brexit” and were favoured by various market participants.

On Sunday the Prime Minister went considerably further. She stated that the UK intends to take back control of its laws and borders. This implies that there will be no deal trading freedom of movement for continued membership of the single market, as some have been suggesting. She made it clear that she will send an Article 50 letter notifying the EU of the UK’s withdrawal no later than the end of March 2017, and will introduce to Parliament a Bill to repeal the 1972 European Communities Act in the next session in 2017. The market now has rough timetable for the UK’s exit, and an official steer that any negotiations with the rest of the EU will rule out limits on the UK’s ability to govern itself. None of these decisions and statements have knocked the share markets. Indeed UK equities for the smaller largely UK based companies have just hit new highs on the relevant indices.

The negative forecasts were based on a combination of a large confidence effect from a Leave vote, and subsequent damage to UK trade. Trade will continue on the current EU basis this year and next, as we are likely to remain full members of the EU over that period. Thereafter trade will be affected by what changes if any there are to the current tariff free arrangements. Optimists think it unlikely the continental countries will agree amongst themselves on a range of tariffs to impose on the UK’s trade with them, as it would mean tariffs on their exports to the UK. Under World Trade rules the tariffs would average considerably less than the competitive advantage the UK has gained from the devaluation, so there is a limit on just how far a vengeful EU could go even if they wished to. German industrialists are unlikely to want a 10% tariff on their cars and French farmers would be unhappy about high agricultural tariffs which are possible on some products under WTO schedules. Pessimists fear there will be tariff and other barriers imposed under WTO rules which could reduce the trade component of both UK and EU output modestly.

The UK share markets have been very positive since late June, and now reflect the reality that so far the UK economy has done reasonably well after the vote.

The above article by John Redwood, Charles Stanley’s Chief Global Strategist, was first published by Charles Stanley on 4th October 2016.

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